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Unformatted text preview: AEM220, Introduction to Business Management. AEM220, Wednesday 10/8 Decision making Decision Making Breakeven point and payback time Time value of money and net present value The Decision Making Process The
Define the problem Identify and weight decision criteria Generate alternative courses of action Evaluate the alternatives Choose an alternative Breakeven Analysis Breakeven
A means of finding the point, in dollars and units, means at which costs equal revenues; at Fixed costs Costs that continue even if no units are produced. Costs Another name for fixed costs is indirect costs. costs. Variable costs Costs that vary with the volume of units produced. Costs Another name for variable costs is direct costs. Yet a third name is cost of goods sold (COGS). cost Formulas for finding the breakeven point Formulas
Breakeven point in units Total fixed costs / (Price – Variable cost) (Price – Variable cost) is called contribution margin (Price contribution Breakeven point in dollars Total fixed cost / (1 – (Variable cost / Price) ) Multiproduct case Total fixed cost / Σ (1 – (Variable cost (i) / Price (i)) * w(i)) Total Example
Average Starbucks location – Manhattan 750 sqft - $400/month/sqft FC = $300,000 / month Average sale / customer = $7 (includes possible water, sandwiches and other items!) Cost per sale = $4 (raw materials + labor) BEP = $300,000 / ($7 - $4) = 100,000 customers/month!!! Or about 5000 customers / working day… How many people walk a Manhattan street a day? Assumptions of Breakeven Point Model Assumptions
Constant fixed costs; Linear variable costs; No consideration of financing, interest rates and No time value of money. time Time Value of Money Time
Present value How much you got now Future value How much what you got now grows to when How compounded at a given rate compounded FV= PV (1 + i )^N Time Value of Money: Example Time
A sweepstakes promises to make you a sweepstakes millionaire. If you win, you will receive payments of $50,000 for twenty year. What is the real real value of the prize? value Annuity A bunch of equal payments made regularly, like every bunch month or every week. month What is the tax rate? What happens if (God forbid) you die? What would be a fair price for this stream of What payments? payments? Considerations Comparing Investment Opportunities: Comparing Net Present Value
The difference between the present value of the The cash flow generated and the present value of the investment incurred. the NPV = ∑ (I(t) – O(t)) / (1 + i)^t NPV (I(t) I(t): Annual Inflows O(t): Annual Outflows Interest rate Time Cost of capital Return from benchmark investments Average returns from stockmarket, or primerate. Calculating I Payback Period: What it looks like Payback
Server consolidation Investment: $1 million Year 1 2 3 4 5 Total $1,000,000 $333,333 $333,333 $333,333 ATM installation Investment: $1 million Savings $250,000 $250,000 $250,000 $250,000 $250,000 $1,250,000 Payback Period calculation answers the question: how long will it take to 3 years 4 years A payback payback get my money back? But it does not say much about the investment after the payback point. For example, a bank can spend $1 million on server consolidation and recoup its costs in three years. Or the bank could spend the same amount on ATMs and recoup its costs in four years. The server project is the payback winner, but the ATM project saves $250,000 per year indefinitely. project Some important strategies Some
Leverage By borrowing rather than investing, you can increase your By rate of return substantially; rate BUT, paying back debts takes precedence over obtaining a BUT, profit. profit. The lower the cost of your capital, the higher the NPV of The potential business opportunities; potential By decomposing an investment into more self-contained By parts, you can allocate capital expenses across time, and increase NPV. increase Cost of capital Decomposition and real options Group Decision Making
Structured conflict “Devil’s advocate” Nominal group technique Delphi technique Brainstorming Electronic brainstorming Take-Aways Take-Aways
Decision making is a discipline Breakeven point Payback period Sinking money now to obtain a greater reward in the Sinking future future Determinants: inflows, outflows, interest rate. NET PRESENT VALUE Investment Group based decision making techniques help Group increase choice and accuracy of solution, and bring commitment. bring ...
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